Look, I understand where Mark Glennon (owner of Wirepoints) and Mish (who also talks about the need for a federal bankruptcy process for states) are coming from – they’re both in Illinois, and in the Chicago area (sorry guys, I’m not checking out exactly where y’all are.)

They would love some outside force to come in and force Illinois politicians to behave in order for the state to get to fiscal stability and reliability.

But it’s UP TO THEPEOPLE OF ILLINOIS to do this.

And yes, it’s going to be a hell of a lot more difficult than having a federal bankruptcy process.

That’s the point.

I AGREEWITHMARKANDMISH ON A LOT

I mention Mark Glennon and Mish (Mike Shedlock) specifically, because I read their material every day, and have for years. So I’m familiar with their particular drumbeats.

What Illinois needs is a genuinely believable, comprehensive five-year recovery plan. To be believable, that plan should include pretty much every reform mentioned in recent years. More importantly, it would have to include debt reduction, including unfunded pension liabilities, and there’s only one way legally to do that — bankruptcy. The United States Congress has to authorize bankruptcy for states.

To those who think otherwise I repeat my standard challenge. Show me the alternative. Show me a rough outline of a financial plan that truly puts Illinois on a path to financial stability without the debt reduction only bankruptcy offers. There is none.

I don’t agree with Mark’s conclusion at all. I do agree with pretty much everything else that he writes.

I agree with this:

The budget the General Assembly now appears ready to pass is just plain silly. It does nothing to address the $15 billion unpaid bill backlog. It doesn’t deal with the recent court order to pay Medicaid bills. It doesn’t fund the new school aid formula passed by the General Assembly. It doesn’t eliminate most of the spending cuts social service organizations have endured. Most importantly, even ignoring those things and more, it pretends to close a deficit that’s in fact two or three times larger than the obviously phony numbers used by Illinois to measure deficits.

And I agree with this:

Madigan having trouble threading the needle. Wants downgrade so he can use the Governor Junk charge while trying to appear constructive. https://t.co/nH2vCQZ2Fb

Federal law allows local governments to seek Chapter 9 bankruptcy protection given a filing is permitted under state law.

States impose a range of restrictions and qualifying criteria for municipalities attempting to file for Chapter 9, with only about half of state laws specifically authorizing municipalities to file. In Oregon, for example, only irrigation and drainage districts can file for bankruptcy. Montana allows for most municipalities to file for Chapter 9 bankruptcy, with the exception of counties.

Other state statutes are without rules governing Chapter 9 filings. Georgia municipalities are explicitly prohibited from seeking bankruptcy protection.

It is undeniable . . . that Chapter 9 is no longer of interest only to bankruptcy lawyers. As elected officials, county and municipal managers, budget officials, bond lawyers, financial advisors and capital markets address the problems now before them, and hopefully the plans for a prosperous future, all such participants should become increasingly knowledgeable of what can and cannot be accomplished in Chapter 9. [NAT’L ASS’N OF BONDLAWYERS, MUNICIPALBANKRUPTCY: A GUIDEFORPUBLICFINANCEATTORNEYS 103 (2011), available at http://www.nabl.org/uploads/cms/documents/municipal_bankruptcy_a_guide_for_public_finance_attorneys.pdf.

Meanwhile, Colorado, Illinois, and Oregon provide specific authorization but in a limited manner. For example, in Illinois, only municipalities with less than 25,000 residents are specifically authorized to file under Chapter 9. However, this authorization is only possible after compliance with a lengthy and cumbersome pre-filing process. On the other hand, cities with populations exceeding 25,000 must utilize the Financially Distressed City Law, which provides for a form of receivership proceeding only for “financially distressed” cities as labeled by the state.
…..
Local municipalities inherently understand their financial situation and possible need for Chapter 9 relief more so than states, which often consist of thousands of local governments. For example, in Illinois, it is hard to imagine that any one of the state-imposed limitations or preconditions is truly in the best interest of all 6,963 of its municipalities. [BRIAN COSTIN, ILL. POL’Y INST., TOOMUCHGOVERNMENT: ILLINOIS’ THOUSANDS OF LOCALGOVERNMENTS 1 (2013), available at http://illinoispolicy.org/wp-content/files_mf/1384372675Too_much_gov.pdf. Illinois has the most units of local government of any state in the country, followed by Texas at 5,147. Id. ]

Bankruptcy is not an option for Illinois cities or other units under current law

July 29, 2013

Perhaps you’ve started wondering whether the Bankruptcy Code could offer a fresh start to Illinois, Cook County, Chicago, or other units of the state. Through bankruptcy, maybe they could cut some debt, renegotiate labor contracts, reduce pension liabilities, reschedule obligations, cancel bad contracts — all things that happen in the private sector? Bankruptcy occasionally works for people and companies so why not for government?
……
How about Chicago, Cook County or other troubled units of the state? Chapter 9 is for local units like those only in states where Chapter 9 is allowed, and Illinois doesn’t allow it (except for very small units under narrow circumstances). Pew Charitable Trusts this month delivered a nice study of different state approaches to what they allow. In Illinois, Chapter 9 filings generally are not authorized. Instead, for cities over 25,000 population, the state has only the Financially Distressed City Law, which provides for a sort of receivership proceeding only for very, very distressed cities which the state labels as such by joint resolution of the legislature. Illinois has only one “financially distressed” city, East St. Louis, which has struggled under that status for 23 years. Chicago, Cook County and most other municipalities would not meet the requirements of the statute.

Couldn’t Chapter 9 be amended to allow states to file or to make it work properly for all cities and municipalities? Or couldn’t the Financially Distressed City Law or other statutes be changed by the state to allow for a smart reorganizaton? Yes, theoretically, but be careful what you wish for. If those laws are amended by the same forces that broke us, those powers will only write themselves into still stronger positions. Pension obligations, for example, could get a first priority. Public unions have already figured this game out, which is why they want those “guaranty” provisions written into pension reform legislation assuring that pension contributions get made ahead of other payments.

Even if Illinois allowed Chapter 9 proceedings for its local units of government, a mess could result because Chapter 9 itself is vague and untested. The Federal Bankruptcy Code became law in 1982 and extensive case law since then now makes private sector proceedings quite predictable, rational and fair. Chapter 9 government proceedings, however, have been rare, so nobody really knows how Chapter 9 cases like Detroit’s will turn out.

In short, the concept of a “fresh start” — which is the ancient legal precept of bankruptcy law — doesn’t exist for government in Illinois, and only a dramatic turnover in Springfield could change things.

None of this is to say that the state or any of its cities other units aren’t broke or “bankrupt” in a figurative sense. It just means no orderly process for reorganization exists, which will make things extraordinarily messy eventually.

Hmmm, I agree with July 2013 Mark Glennon. But here, he’s arguing about the “will” versus the “should”.

In any case, not only can’t Illinois declare Chapter 9 bankruptcy right now, but also Chicago can’t. Cook County can’t.

States face colossal fiscal pressures, including mounting public pension obligations that now represent a $1 trillion unfunded gap, according to the Pew Center on the States. That gap—combined with other mounting fiscal woes—has led to a national conversation about whether states should be allowed to file for bankruptcy. That conversation has prompted state officials to react, most arguing that the mere existence of a federal law allowing states to declare bankruptcy would increase interest rates, rattle investors, raise the costs of state government, create more volatility in financial markets, and erode state sovereignty under the 10th Amendment to the U.S. Constitution. To help explain this complicated issue, CSG asked Kenneth Katkin, a law professor at the Salmon P. Chase College of Law at Northern Kentucky University, a few questions about bankruptcy and states.

Why can’t states use the federal bankruptcy system to reorganize their debt?

“There are two reasons why state governments currently cannot use the federal bankruptcy system to reorganize their debt. First, the federal bankruptcy code does not allow—and has never allowed—state governments to declare bankruptcy. Since 1937, the bankruptcy code has allowed ‘municipalities’ to declare bankruptcy. The term ‘municipality’ is defined in the bankruptcy code as a ‘political subdivision or public agency or instrumentality of a state.’ This definition is broad enough to include cities, counties, townships, school districts and public improvement districts. It also includes revenue-producing bodies that provide services which are paid for by users rather than by general taxes, such as bridge authorities, highway authorities and gas authorities. But it does not include state governments.

“The second reason stems from the U.S. Constitution. The contracts clause of the U.S. Constitution prohibits state governments from ‘impairing the obligation of contracts.’ As originally understood and enforced, this clause prohibited state legislatures from passing any laws to relieve either private debt or the state government’s own debt. Beginning in 1934, however, the Supreme Court began to interpret the contracts clause more flexibly and not as an absolute bar to state debt relief laws. Even under the flexible modern approach, however, the Supreme Court in 1977 reiterated that ‘a state cannot refuse to meet its legitimate financial obligations simply because it would prefer to spend the money (on something else.)’ Thus, were Congress to amend the federal bankruptcy code to authorize states to repudiate debt, the Supreme Court would then need to decide the novel constitutional question of whether such debt repudiation would nonetheless violate the contracts clause of Article I, Section 10.”

No State shall enter into any Treaty, Alliance, or Confederation; grant Letters of Marque and Reprisal; coin Money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts; pass any Bill of Attainder, ex post facto Law, or Law impairing the Obligation of Contracts, or grant any Title of Nobility.

No State shall, without the Consent of the Congress, lay any Imposts or Duties on Imports or Exports, except what may be absolutely necessary for executing its inspection Laws: and the net Produce of all Duties and Imposts, laid by any State on Imports or Exports, shall be for the Use of the Treasury of the United States; and all such Laws shall be subject to the Revision and Control of the Congress.

No State shall, without the Consent of Congress, lay any Duty of Tonnage, keep Troops, or Ships of War in time of Peace, enter into any Agreement or Compact with another State, or with a foreign Power, or engage in War, unless actually invaded, or in such imminent Danger as will not admit of delay.

Hmmm.

I came across a bunch of articles from 2010 and 2011 re: potential state bankruptcies.

There is a debate raging right now about whether Congress should create legislation giving states the option to file for bankruptcy, something along the lines of the existing law allowing for Chapter 9 municipal bankruptcy. To be sure, states are in big trouble: Total state debt is estimated at over $1 trillion, and that’s in addition to unfunded liabilities (from pensions and other obligations), which are estimated at over $3 trillion. Given the federal government’s $9 trillion in existing debt — which, according to a recent CBO report, will double in the next ten years — taxpayers cannot afford to bail out the states. Nor can we afford the precedent it would set. Federal bailouts should be off the table.

In light of this looming problem, many people have argued for state-bankruptcy legislation — most recently, Newt Gingrich, writing with Jeb Bush at the Los Angeles Times.

….
In many states, bankruptcy will be an option for lawmakers if and only if powerful unions and other interest groups see it as a way to force the state’s budget problems onto the state’s bondholders. In the end, it could be a way for these interests to postpone needed pension and public-sector-union reforms.

To be sure, that came years after the above piece, but I don’t think public employee unions find this option all that attractive, if they ever did. The unions didn’t seem to be too happy about a Detroit bankruptcy even before it became official or pension cuts for retirees was mentioned.

Saturday’s New York Times has an article on Illinois’ finances that is must reading for anyone who thinks the U.S. has turned the corner. The crucial takeaways are 1) even though states can’t technically declare bankruptcy, they apparently can just stop paying their bills, 2) while salaries and pensions for current public sector workers are untouched, services that provide lifelines to the most vulnerable are being decimated, and 3) though Illinois is arguably the worst-run state, a whole bunch of others are close behind, so what happens there will soon be replicated across the country.

For the last few years, California stood more or less unchallenged as a symbol of the fiscal collapse of states during the recession. Now Illinois has shouldered to the fore, as its dysfunctional political class refuses to pay the state’s bills and refuses to take the painful steps — cuts and tax increases — to close a deficit of at least $12 billion, equal to nearly half the state’s budget.

Policymakers are working behind the scenes to come up with a way to let states declare bankruptcy and get out from under crushing debts, including the pensions they have promised to retired public workers.

Unlike cities, the states are barred from seeking protection in federal bankruptcy court. Any effort to change that status would have to clear high constitutional hurdles because the states are considered sovereign.

But proponents say some states are so burdened that the only feasible way out may be bankruptcy, giving Illinois, for example, the opportunity to do what General Motors did with the federal government’s aid.

It’s so amusing how often Illinois comes up in this.

Amusing? I mean, predictable.

A DETOUR

This morning, I started out from Durham to get to New York. I’m in Durham right now.

On December 19, 2010, in an interview on the CBS television program 60 Minutes, Whitney stated that 50 to 100 counties, cities, and towns in the United States would have “significant” municipal bond defaults totaling “hundreds of billions” of dollars, and that “it’ll be something to worry about within the next 12 months.”3 Since the record amount of municipal bond defaults in one year was just over $8 billion at the time, Whitney’s comments about hundreds of billions in defaults briefly shook the market and drew a great deal of attention, much of it critical.2021 She later described her forecast as a “guesstimate” involving “fifth-derivative dimensions”.7 Her prediction was far in excess of what actually occurred in the following years, including record-setting defaults by Jefferson County, Alabama in 2011 ($4 billion debt, $1 billion loss),22 Detroit in 2013 ($18 billion debt, $7 billion loss),23 and even Puerto Rico in 2017 ($74 billion debt, with loss to be determined by bankruptcy court).24

According to Michael Lewis in Vanity Fair: “Many of the articles attacking her accused her of making a very specific forecast — as many as a hundred defaults within a year! — that failed to materialize… But that’s not at all what she had said: her words were being misrepresented so that her message might be more easily attacked. ‘She was referring to the complacency of the ratings agencies and investment advisers who say there is nothing to worry about,’ said a person at 60 Minutes who reviewed the transcripts of the interview for me, to make sure I had heard what I thought I had heard. She says there is something to worry about, and it will be apparent to everyone in the next 12 months.”21

Unfortunately, she was wrong about even that last bit.

I think she was fooled by the way companies go bankrupt versus goverments. There’s a lot of magical thinking surrounding governments which can last only so long when you’ve got a company with no revenue growth, and indeed revenue decreases.

So no, it wasn’t apparent to everybody within a year, though there was a lot more attention being brought to the matter.

There are lots of people, including bondholders and pensioners, who think they’re going to get the full measure of what they were promised. The money will appear!

These people aren’t going to take any of this seriously until the money dries up. The pension funds run out of assets. The bond market not ponying up.

And, most importantly from the decision-makers’ point-of-view: losing elections and power to control the decisions they’re currently controlling. That’s pretty much what it takes to get their attention… and even then, they have a huge incentive to misinterpret the reason they got the boot. (RUSSIANS!)

THEMEEPPRESCRIPTION

As for my own prescription for fixing the Illinois situation, I do agree with Mish’s proposed reforms, but this is what it’s going to need to really fix Illinois’s hole:

The ruling is based on a specific clause in the Illinois state constitution. The current constitution was put together and ratified in 1970.

Let’s take a look at the specific clause in question: Article XIII, section 5 of the Illinois state constitution.

….SECTION 5. PENSIONANDRETIREMENTRIGHTS

Membership in any pension or retirement system of the State, any unit of local government or school district, or any agency or instrumentality thereof, shall be an enforceable contractual relationship, the benefits of which shall not be diminished or impaired.

Guess what needs to be changed.

Hell, I will just recommend to amend the state constitution by removing section 5 entirely.

This is not likely to happen.

In order for this to happen, the following is needed:

Illinois voters have to give Madigan, Cullerton, and crew the boot

Now, it’s not accidental that Madigan has been the speaker of the Illinois House from 1983-1995 and 1997 – now.

Madigan has been in the Illinois House since 1971. Oooh, let’s see if he can hold on for fifty years! He’s almost there!

The only thing that gets career politicians’ attention is losing.

Thing is, I believe many Illinois voters love the lies that this is just some minor political squabble as an insufficiently groveling Rauner ain’t respecting Madigan’s authoritah!

They love hearing that the pensions will actually get paid… somehow… I know, by soaking the rich! And financial transaction taxes!

They love hearing about those clever quick fixes called pension obligation bonds!

Man, Bill Bergman’s idea of turning Illinois into a giant hole is looking better and better.

I could go further down this path and recommend replacing the electorate to one likely to boot people who have been there longer than I have been alive (Rauner couldn’t get term limits to go anywhere, note)… but nope.

NO BAILOUTS

Part of the problem is that pretty much everybody seems to think some sort of bailout will come, like a deus ex machina.

BEHOLD! I BRINGFISCALSANITY!

The pensioners assume taxpayers and/or rich people will cover all their wants. Politicians think that if the money doesn’t appear, at least they will be dead before this really gets into trouble.

Hmmm, planning on dying before 2030?

The feds aren’t going to help.

They can’t help. If people really were aware of the seriousness of the Illinois hole, they’d be aware of the troubles of Social Security, Medicare, and Medicaid. And how deep the holes for California, New Jersey, Kentucky, and Connecticut are. And Texas. And South Carolina. … it’s not just the “blue” states.

An analysis by the Pew Center on the States found that at the end of fiscal year 2008, there was a $1 trillion gap between the $2.35 trillion states and participating localities had set aside to pay for employees’ retirement benefits and the $3.35 trillion price tag of those promises.

You would think that after several years of a bull market, and pension reforms, things would be better.

The gap between the total assets reported by state pension systems across the United States and the benefits promised to workers, now reported as the net pension liability, reached $1.1 trillion in fiscal year 2015, the most recent year for which complete data are available. That represents an increase of $157 billion, or 17 percent, from 2014.

The feds doesn’t have a spare trillion to stuff into the pension hole, which all the states would be demanding if Illinois were made whole due to federal intervention.

I know everybody is gazing fondly at Puerto Rico – a territory with a population of about 3.5 million and falling.

You think Illinois, the state with the 5th largest population, is going to get an oversight committee that will call all the fiscal shots, like with Puerto Rico?

What the hell do you think would happen in a state bankruptcy through the federal courts? People like Madigan would be putting together the fiscal plan — Detroit didn’t have that happen because the Republican state governor imposed oversight in the form of an emergency manager on Detroit. The local politicians were fighting this in court, fwiw.

You can’t fix the state’s problems by keeping the same people in power. The feds can’t fix that for you.